For Your Financial Plan- Be Like GumbyJanuary 26th, 2021 by Jim Allen
When it comes to financial planning, being flexible is the key to long term success. Whether you are a pre-retiree or recently retired, you are potentially facing a 25-to-35-year retirement. With the current trend of increasing longevity, you could spend more time in retirement than you did working. So, what does this have to do with Gumby, the beloved toy and TV/ movie character from our youth? Like Gumby (and his faithful sidekick / horse Pokey), the secret to success in his adventures was his flexibility. This feature got Gumby out of a lot of situations and building flexibility into your financial plan is also the key to your long-term success.
Over a 25+ year retirement, there are going to be several ups and downs and unknown events. Investment performance, tax rates, inflation and your personal health will change multiple times over the rest of your life. The current COVID pandemic is a clear example of an unexpected event that can turn your finances upside down. Consequently, we cannot (and shouldn’t) clearly define a straight path in retirement. We need to be able to adjust to life changes as they occur, and if a rigid and inflexible plan is developed, we will not be successful. While every aspect of your financial plan needs to be flexible, here are just a few examples.
Over the history of the Internal Revenue Code, there have been major tax changes on average about every 3-4 years. This means that you will likely see 6 to 7 more tax law changes during retirement. This means that if you assume that you will be in a lower tax bracket (like you have probably been told for years), you can be in for a rude awakening. For example, a person who retired in 1990 was in a top bracket of 28%, but by 1993 was in a top bracket of 39.6%.
The solution to the uncertainty of future tax law changes is to use “tax diversification”. The concept of tax diversification is to have multiple sources of income that have different tax treatment. This usually means having assets in a taxable IRA, a tax-free Roth IRA and a partially taxable individual account. By having multiple tax buckets, we have the flexibility to pull income in the most tax effective manner for your current tax situation. With tax diversification, we can adjust which bucket to pull from each year as your tax situation changes.
One of the major decisions that pre-retirees need to make is whether to carry a mortgage into retirement. We have written previous articles on this topic, and for some people it is important to have a “paid for” home in retirement. But, for others the idea of being “house rich and cash poor” is the more uncomfortable scenario.
If you are going to carry a mortgage into retirement, having a 30-year mortgage instead of a 15-year may be a better alternative and provide additional flexibility. While a 15-year mortgage will pay off the home quicker and will usually provide for a lower interest rate, it will also lock you into a higher required monthly payment. However, if you have a 30-year mortgage, your payment will be lower and you can always make extra payments as desired to pay off the home quicker. The benefit is that you will have a lower payment when those what ifs like the COVID pandemic impact your earning power or your portfolio. During a financial downturn, you can simply pay the lower mortgage payment and then return to a higher or extra payment as conditions improve. Again, flexibility can be a game changer during those periods of uncertainty.
One of the biggest drivers of success in retirement is being flexible with your spending goals. While many financial planners look to show a constant pattern of inflation-increased spending every single year, this results in a higher nest egg goal, or the need to work longer, save more or to take on more risk than may be needed. If we develop a flexible spending plan that has “guardrails” which adjust spending upward or downward depending on economic conditions, a more achievable plan can be developed. The way this works is that you may not take a spending increase or may even slightly decrease your spending during economic downturns but then increase spending during times of economic growth. Even very small adjustments can have a significant effect over a 25-to-30-year retirement. Going into retirement with the expectation of being flexible with your spending may result in being able to meet your retirement goals sooner or with less savings than anticipated.
These are just three examples of how developing a dynamic and flexible financial plan can help you achieve greater financial success. Our holistic and comprehensive “MoneyLife” approach to financial planning is based on customization and flexibility. “Semper Gumby”
Jim Allen, CFP, ChFC, CDFA, EA is the Director of Financial Planning and a Principal at Anchor Bay Capital. In addition to his 30 years of financial planning experience and his professional credentials, he holds a Master’s Degree in Financial Planning and is a former instructor in the CFP program at the University of California Irvine. He is also the co-author of the book “The Tools & Techniques of Charitable Planning” and is an Enrolled Agent admitted to practice before the IRS. Jim can be reached at [email protected]